Banking supervision: The prevention mechanism option
By Enitar Ugwu
AS the saying goes: prevention is better than cure. In the Nigerian banking clime, that seems to be only option left for the regulators in their bid to keep the nation's banking sector on the path of sanity.
In a bid to achieve this, the Governor of the Central Bank of Nigeria (CBN), Sanusi Lamido Sanusi, as soon as he took over at the apex bank, had announced that in moving forward, consolidated supervision was it.
Meaning that the supervision of the finance industry would no longer be done piecemeal and individually by different regulatory authorities. The affected bodies including the CBN, Nigeria Deposit Insurance Corporation (NDIC), Securities and Exchange Commission (SEC), Nigerian Stock Exchange (NSE) among other regulators.
According to Sanusi in June, "I plan to work very closely with NDIC, Pencom, SEC and the Stock Exchange and try to harmonise an approach, and try to send joint teams to supervise and try to look at the financial system as a whole and see how we can play our part in addressing these issues."
Earlier on, he had stated that, "also, we need to sit with other regulatory bodies and agree on code of conduct for regulators.
The problem is not just the CBN. A lot of this problem has also come because of governance issues in the stock exchange, SEC rules around insider trading, rules around margin lending and the conduct of stock brokers."
Interestingly, the CBN and NDIC have made known their intention to refocus their regulations and supervision of the banking system on prevention mechanism.
The duo made this known last weekend in Kaduna at the seminar for finance correspondents and business editors.
The decision to refocus their regulation and supervision was a fall-out of some of the lessons learnt from the banking sector crisis. The Deputy Director, Banking Supervision Department of the apex bank, Mr. Charles Akorodu, said: "There is the need to refocus regulation on preventive actions".
To achieve that, he said, the CBN henceforth will subject banks to consolidated supervision as well as tie incentive systems of bank executives and their remuneration to risk management capabilities.
He also said the CBN would be establishing Memorandum of Understanding (MoU) with supervisors in countries where Nigerian banks currently operate to facilitate regular exchange of information.
"Going forward we will not allow our banks to open shop in any country with which we have not established such a Memorandum of Understanding," he said.
According to Akorodu, "the more time we spend on prevention, the less time and resources would be expended on crisis resolution". On the part of the NDIC, the preventive measures against future bank crisis, according to the Managing Director, Mr. Ganiyu Ogunleye, is downturn review of the Single Obligor Limited (SOL) of banks, which currently is 20 per cent.
The NDIC boss noted that there was need for a risk based management approach as a way of mitigating risk in the sector, adding that the recent crisis in the industry serves as an eye opener to improve on risk management.
He disclosed that out of the 24 existing banks, First Bank voluntarily reduced the SOL to 10 per cent.
Ogunleye added that in the light of the recent developments in the industry, there are salient governance issues to be addressed.
He pointed out that in the cause of its examinations, the NDIC found out there were no contractual agreements on tenure of Chief Executive Officers (CEO). According to him, that may no longer be the order of the day.
He said it is imperative that each bank put in place a binding contract for tenure of its CEO, adding that regulatory intervention in eight of the 24 banks underscored the need for professionalism and sound ethical practices in the banking system.
The NDIC is strongly seeking a transformation in borrowing culture. Ogunleye said the creditor rights mechanism requires a drastic overhaul through appropriate legislation.
"The procedures for taking and enforcing collaterals are most inefficient as debtors easily frustrate creditor banks by abusing the judicial process. The corporation had come across debtors who would prefer to engage solicitors that could protract cases in court for many years rather than making effort to resolve their debt obligations.
Bank debtors with such a mind set constitute a threat to efficacy of the proposed Asset Management Company (AMC),"he said.
It would be recalled that The Guardian had earlier reported that in order to key into the new supervisory regime, the nation's banks are now embracing Internal Capital Adequacy Assessment Process (ICAAP).
ICAAP is a system whereby a bank ensures that its capital meets the risks it is exposed to.
According to investigations by The Guardian, these banks now see the adoption of ICAAP as one way of avoiding the recent embarrassment of over-exposure to margin lending and lending to oil marketers, which gave rise to huge non-performing loans.
The Chief Risk Officer of UBA Plc, Andre Blaauw, said: "The ICAAP is integrated with the bank's risk management system and uses output of the risk measurement system, noting that capital is a buffer to absorb losses (write down) of assets during times of distress."
He explained that the larger the capital buffer, the more losses that could be absorbed to protect depositors' funds. But stressed that high capital adequacy levels will not necessarily guarantee that depositors' funds were protected.
Buttressing his point, Blaauw pointed out that some of the nation's banks that had to be bailed out by the CBN recently had capital levels in excess of 20 per cent of risk assets, which could be considered high by international standards, yet, when they (banks) had to provide for potential losses, some were found to be below the regulatory minimum of 10 per cent.
Rather, the Chief Risk Officer submitted that the risk of the assets and the strength of risk management practices would determine whether depositors would be protected or not.
Speaking to The Guardian , a top management worker of one of the banks confided that "a lack of ICAAP is one of the pitfalls the banks fell into that led us into this mess."
He pointed out that even the boards of directors of the various banks that were supposed to champion it, did no such thing, as they were busy lining their pockets.
He explained that the CBN having established the framework for a risk-based supervision for banks, had played its part, but now it was left for various banks, knowing the risks they were exposed to in their operations to institute ICAAP to cover those risks.
The various boards, he stressed, failed in this duty, hence the crisis in the banking industry.
His view tallied with that of Blaauw when he said that it was not the responsibility of a central bank to ensure that every bank was adequately capitalised for all risks that it was exposed to, pointing out that the central bank set minimum capital requirements for the system that were generic and not related to the specific risks of the banks.
Banks that take large exposure in high risk assets, such as margin lending, he said, would need much more capital to absorb potential losses than those banks with limited exposure in these assets, adding that, the central bank minimum capital rules did not address the potential losses for each specific type of risk in the bank's balance sheet.
The onus, he said, is on the bank to assess its own capital adequacy for specific risks.
However, he explained that, the central bank must ensure that there was a thorough review of banks' ICAAP results, methodologies, input and assumptions among other things, adding that "the central bank must further have a framework to quantify capital add-ons required, should the bank's ICAAP and risk management framework not be sufficiently robust."
It is based on the foregoing that he stated that the new CBN risk-based supervisory framework would provide the platform for ongoing review of banks' ICAAP.
On the role of banks boards of directors, he stressed that the ultimate responsibility for the ICAAP was with the boards, as ensuring the capital adequacy of a bank could be regarded as the most important function of a bank's board.
On the strength of that assertion, according to him, the board of directors is thus responsible to: set tolerance for risk, ensure that the senior management of the bank establishes a risk management framework in order to assess and appropriately manage the risk exposure of the bank, develop a system to relate the bank's risk exposure and potential losses to the bank's capital and reserve funds; and ensure that the bank has an appropriate capital plan in place, which capital plan, as a minimum, shall duly outline the bank's minimum capital level required to absorb potential losses, capital required for growth, the bank's desired capital level and the capital supply plan.
In his recent assessment of current developments in the nation's economy and the CBN policy action, Sanusi had this to say: "Banks would be required to further strengthen their risk management process, while the present supervisory methodology of risk-based and consolidated supervision with special emphasis on macro-prudential regulation and sound stress testing practices would be pursued more vigorously."
He added: "More and rigorous emphasis would be placed on the implementation of the Code of Corporate Governance for banks in Nigeria," advising that, "banks that have not fully complied with the requirements of the code would be encouraged to do so."
Based on that, he warned: "For the avoidance of doubt, enforcement of the code of conduct on the board and top management of banks, especially in the areas of display of professionalism and high ethical standard shall not be compromised."
